The Importance of a Global Approach to Regulating Corporate Governance - Essay Example

? THE IMPORTANCE OF A GLOBAL APPROACH TO REGULATING CORPORATE GOVERNANCE Table of Contents Table of Contents 2 Introduction 3 Corporate Governance 4 Agency Problems 6 Critical Review 9 Conclusion 11 References 13 Critically analyse the importance of a global approach to regulating corporate governance, focusing (with examples) on the problems/benefits that this may cause Multi-National Corporations. Introduction With growing impact of globalisation a lot of business organisations are observed to expand their business activities in different regions of the world in the recent times. Consequently, there has been a significant increase in the demand for permanent funds that can be helpful for companies in their process of expansion in size and production. Hence, the ownership structure of the multinational corporations (MNCs) is also becoming increasingly complex because of more external financing methods being employed by them. Thus, the investors of a company who are involved in the process of providing funds for the MNCs form a particular group of stakeholders and they have their own specific interests in the companies. In order to address these additional interests of the investors the companies need to harmonise these with the other stakeholders’ interests to form a new organisation system and structure that brings together all these ambiguous objectives together. This type of new organisational system has been found to evolve in the 20th century and is termed as corporate governance (Herrigel, 2006). It can be argued that global approach is not required to work under the regulations set out in the corporate governance mechanism. However, in order to argue on such issue the agency problem should be considered that takes place within the organisational structure of a public company. Moreover, it is also required to evaluate that whether taking a global approach towards corporate governance can result in harmonising the various interest groups or not. One also needs to find out the merits and demerits for business organisations derived through the application of such global approach towards corporate governance. This study entails about researching on these specific aspects and also includes relevant examples that form a strong evidence for the opinion presented at the end of the paper. Corporate Governance Corporate governance can be considered to be a recently coined term and has a significant impact on the business operations carried on by the companies (Solomon, 2011). Corporate governance is used in various ways and one particular definition is not sufficient to completely define corporate governance. Generally, a wide variety of issues that are related to the various ways through which business activities carried on by the business organisations can be directed or controlled is described through the term corporate governance (Turner, 2009, p. 5). If we look at it in a broad sense, corporate governance can be viewed as a system of codifying the conduct of business activities that are followed by different organisations. The wider issues that are related to improving the shareholders’ performance are also included in the corporate governance mechanisms followed by the companies. Certain issues that are associated with the company’s stakeholders like the accountability of the business firms towards fulfilling particular interests of the stakeholders are also addressed through corporate governance. Stakeholders constitute of anyone who has a relation with the company including the shareholders, customers, suppliers, employees, community, etc (Turner, 2009, p. 5). There are many theories which have evolved to address the growing development of corporate governance issues all around the world. According to Mallin (2007), some of those corporate governance theories include, the agency theory, transaction cost economics, the stakeholder theory, the stewardship theory, class hegemony, and managerial hegemony. The agency relationship is identified through the agency theory wherein one of the parties termed as principal is engaged in the activity of delegating work to the agent. As regards a business organisation, the owners or the shareholders are the principal and the company directors are considered to be the agent. The organisation itself is viewed as a governance structure in accordance with the transaction cost economics’ postulates. Selecting the best suited governance structure with the implementation of regulatory system in an organisation can be helpful in the process of aligning the interests of the shareholders and the directors. The stakeholder theory on the other hand is concerned with a wider group of people. The governance structure of the company under this theory would facilitate inclusion of some of the direct representatives of the stakeholder groups. Again the stewardship theory suggests that directors of the company are considered to be the stewards of the assets of the organisation and thus are required to act in accordance with the shareholders’ interests. The class hegemony theory of corporate governance suggest that directors form the elite group of the company and are involved in the process of recruiting or appointing new directors of the company taking into consideration the effectiveness of such appointments. On the other hand, managerial hegemony suggests that the company managers who have the better understanding about the daily business operations may have the capability to dominate the company directors in an effective manner. This can result in decreasing the influence of the directors. All these theories related to corporate governance discussed above suggest that there is no one way to manage corporate governance mechanisms followed in an organisation and all these theories have their own merits and demerits. However, with the increasing development of globalisation the multinational corporations are required to operate in diverse business and cultural environments and the regulatory authorities in different geographical regions are striving to harmonise the regulations related to corporate governance to be followed by all the organisations. This can be beneficial for the MNCs to operate and regulate their business activities in a uniform way so that it leads to management effectiveness and efficiencies. However, it is a challenging task to bring about drastic changes in the regulatory framework of a particular region because it can have an adverse impact on the concerned shareholders and stakeholders of the companies. Agency Problems As cited in most of the existing literature, Jensen and Meckling (1976) are most commonly associated with the agency theory of corporate governance. The business activities that are followed by most of the organisations are found to be mostly governed through the contracts that include voluntary exchanges (Alchian and Demstez, 1972). Agency theory is helpful in gaining understanding about the process of organising relationships within an organisation where principal who is one of the parties involved in determining the nature of work to be performed by the other party termed as agent. Agency problems arise in situations where the shareholders of the organisation or the principals are found to be involved in the process of recruiting or hiring managers or the agents in order to help in the process of decision making that is in alignment with the interests of the shareholders. Now in order to support the implementation of global approach towards corporate governance it is necessary to gain insight on the complex organisational structure of some of the MNCs and the various interest groups that evolve through the given organisational structure. The various facts that have been discussed in this section of the paper highlights the increasing ownership issues involved in most of the public companies located in United States and United Kingdom. Usually when a new company is set up, it is generally found to start with an owner of the company who is the chief executive officer (CEO) as well and is involved in managing the business operations carried on in the organisation. However, with the passage of time and with the increasing customer base of the company the CEO would try to expand the business operations in order to capitalise on the available potential growth opportunities. Now, in order to rapidly expand the business, the companies would require more funds to pay for the performance of additional activities. As for example, with the expansion of business the company would require funds to finance the increasing requirements of supplies, raw materials, human resources and so on. During such situation the companies need to look for sources of funds other than loans or debt capital because the organisations would not be able to provide all necessary securities sought by the banks to get loans of such large volumes. The other sources of funds include equity capital and venture capital (FAO Corporate Document Repository, n.d.). However, in situations where additional funds for business expansion are provided through venture capital companies, they also have ownership rights on certain assets and hence can impart their control over the organisations. It might so happen that the venture capital firms may replace owner as the CEO of the organisation if it is found by them that his decisions are not prudent in nature and other managers are available who can operate the business procedures in a more effective and successful manner. During this stage the existing gap between the ownership and control over the company starts to widen up. Hence, the next strategy of the firm would be to conduct an initial public offering so as to facilitate raising more funds required for further expansion of the business. The venture capital company and the actual organisation owner might also get themselves into activities that facilitate diversification of the investment portfolio of the firm and spreading of risk amongst the public. However, with the conversion into a public company, significant power and control of the owner is passed to the new stakeholder groups. With the passage of time, it is more likely that more control is passed to the executives by the owner of the company which are strictly regulated by the company directors. Hence, there is an increasing evidence of widening of gap and divergence of interests between the owner or the principal and the company manager or the agent of a particular business organisation. The stakeholders of the company thus get divided into two broad parts. On one side, they are the institutional investors and financial advisors of the company and on the other side they are the managers, CEO, and the employees who form a separate stakeholder group. The ownership of the company lies in the hands of the shareholders of the company. The shareholders have an interest in the company to see whether the value of their invested funds has increased or not. It is the responsibility of the company to act in accordance with the interests of the shareholders. Financial advisors work for the banking institutions who are involved in buying the company shares in bulk amount and then reselling them to the private investors. These types of financial investors have the power and control over deciding upon investing in the shares of a particular business organisation. The potential conflicts that exist between the agent and the principal results in a situation where the agents get motivated to make contracts with the owners of the company so as to facilitate minimisation of goal incongruence between the principal and the agent (Banker, and Thevaranjan, 2000). It can be found in the agency theory that the agents try to monitor the contracts because the owners’ prices are heavily protected in the absence of such contracts. In order to facilitate minimisation of the total costs that are imposed on the agents they get themselves involved in various bonding activities. According to Godfrey, Hodgson, and Holmes (2003) incentives are received by the agents to minimise the costs that are linked to monitoring the agency contracts because it results in decreasing the compensation received by the company managers. All the factors cited in this section of the paper suggest that it is a challenging task for the MNCs to implement a global approach towards regulating the corporate governance mechanisms followed in the organisations and especially the agency theory of corporate governance. Critical Review There can be a difference in opinions related to the fact that creating a global approach towards implementing regulatory framework for carrying out corporate governance mechanisms in organisations can either be beneficial or pose problems for the MNCs. One cannot be sure that it is necessary to have worldwide convergence into one particular corporate governance model. During the 1990s it was found that many companies tried to move towards implementing the US corporate governance models as it was found to be more effective and efficient then (Holmstrong, and Kaplan, 2003). However, later with the occurrence of several corporate scandals in companies like WorldCom and Enron, other nations turned sceptical about the US models and adjudged them to be flawed. Moreover, with the implementation of Sarbanes-Oxley Act in United States it was found that lot of public companies in US got themselves unlisted from the US stock exchange listings and in turn moved towards listing their shares in the stock exchanges of London and other places to avoid the impact of certain provisions mentioned in the US law. Since, different nations vary in their economic development patterns it is expected that local or regional characteristics would continue to be exhibited in the companies located in various countries. The corporate landscape of a particular nation is found to be influenced through various factors like the economical, political, legal, and historical factors. As a result of this, variation in the board structure and corporate governance mechanisms followed in organisation is observed all around the world. It has been observed that organisations in different geographical areas of the world are continuing to carry on their business activities in the similar ways as they have done always. The US model of corporate governance is found to have evolved in a nation which is mostly characterised of having a diversified group of shareholders. Other stakeholders of the organisation like governments and financial institutions have a very little stake in the US companies (Jackson, 2010). Next, if we look at Europe, it can be found that it has a different feature as compared to that of the US model. There are small number of large stakeholders present in the European based companies and often the representation in the board of directors of the company is sought the financial institutions that have cross-holding in the organisation. If we speak of the German companies, it can be found that the labour unions play a vital role in the society as compared to the United States and hence have a dominating influence in the corporate governance structure of the organisations. Next, if we speak of the Asian continent it can be found that diversified business entities form the basis of the corporate structures and the banks or the financial institutions have cross-shareholding in the companies. As a result of this, within a short period of time the national economies in Asia have experienced economic development through the increased prominence of manufacturing industries. However, the companies are found to be reluctant to implement a change in the organisational system of doing business that has worked so well for them. It can be argued that different corporate governance systems are suitable or appropriate for different industrial sectors. Moreover, the global investors are benefited through diverse structures of corporate governance which might even result in increasing the corporate performance. As for example if we take the instance of Japanese system, they are traditionally characterised of having large size of board of directors. This type of system can be beneficial for the organisations present in industrial sectors that are highly capitalised in nature and need a long time horizon like the automotive industry. On the other hand, the US system which is not found to be management dependent is flexible in nature and helps in the creation of a good economic environment that is beneficial for the innovative and starts up companies. Hence, one particular system cannot be better for all industries and the whole idea that it would be better to have a global corporate governance system that would lead to homogenisation of all the differences in regulations followed in different countries would not work because that is not the manner in which the world works. Even from the investors’ point of view it is not clear as to whether they would want to have a global corporate governance system or not. The investors are found to thrive on the variances that are reflected through the balance of return and risk. While some of the investors are in favour of investing in a low risk and secured environment, others favour investing in ventures associated with high risk which has the potential of generating high returns. The investors want the corporate governance rules to remain same and are not in favour of an unexpected change in the system. The corporate governance rules in Japan can be different from that of the United States but the investors would not face any serious difficulties to get themselves adapted to such situation. However, a sudden change in the system can pose significant problems for the investors and they may not be able to adapt to such changes that easily. Conclusion The discussion and analysis of corporate governance mechanisms followed in MNCs and the approach towards global corporate governance system suggest that although theoretically it can be beneficial for the companies but practically it is a challenging task. No consensus has been made as yet regarding the best system of corporate law that is suitable for all the organisations worldwide and whether the convergence of the corporate governance mechanisms followed in organisations worldwide would increase their performance. To be more specific it is still unknown as to whether a new hybrid model of corporate governance mechanism would emerge or not. The business environment worldwide is changing at fast rate and the corporate governance systems are required to adapt to such changes. It is quite inevitable that certain changes in the governance mechanism would occur but the big question lies behind the fact as to whether the corporate governance in a particular country would be able to successfully adapt to such changes or not. It is unlikely that some drastic change would occur to facilitate the global approach towards regulating corporate governance because the companies as well the investors are found to be reluctant to change a system that has been working well for them till now. Hence, it can be concluded that with the increasing influence of globalisation, and with the organisational structure of MNCs becoming more and more complex, it is certain that some changes would occur in the corporate governance system followed in most of the MNCs but the ultimate convergence towards a particular global corporate governance system to be followed by all the organisations worldwide is very unlikely to occur. References Alchian, A. A., Demsetz, H., 1972. Production, Information Costs, and Economic Organization. American Economic Review, LXII, 5, pp. 777–95. Banker, R. D., and Thevaranjan, A., 2000. Goal Congruence and Evaluation of Performance Measures. [pdf] Available at: [Accessed 14 December 2012]. FAO Corporate Document Repository, n.d. Chapter 7 - Sources of finance. [online] Available at: [Accessed 14 December 2012]. Godfrey, J., Hodgson, A., and Holmes, S., 2003. Accounting Theory. 5th ed. New Jersey: Wiley & Sons. Herrigel, G., 2006. Corporate Governance: History Without Historians. [pdf] Available at: [Accessed 14 December 2012]. Holmstrong, B., and Kaplan, S. N., 2003. The State of U.S. Corporate Governance: What’s Right and What’s Wrong? [pdf] Available at: [Accessed 14 December 2012]. Jackson, G., 2010. Understanding Corporate Governance in the United States: An Historical and Theoretical Reassessment. [pdf] Available at: [Accessed 14 December 2012]. Mallin, C. A., 2007. Corporate Governance. 2nd ed. Oxford: Oxford University Press. Solomon, J., 2011. Corporate Governance and Accountability. 3rd ed. New Jersey: John Wiley & Sons. Turner, C., 2009. Corporate Governance: A Practical Guide for Accountants. London: CIMA Publishing. Read More